The Securities and Exchange Board of India’s (Sebi) proposal to direct upstream clients’ funds to clearing corporations (CCs) could make operations tougher for foreign and domestic institutions serving as clearing members for institutional clients, as it will hit their revenue models substantially.
Last week, top foreign and domestic brokers and clearing members (CMs) met the market regulator to petition against implementing the rule for institutional clients, according to three people aware of the matter. It is not clear if Sebi will agree to this request. An email sent to Sebi did not immediately get a response.
“We have tried to highlight (to Sebi) that the proposal would be more suited for retail investors,” said the head of custody services at a large bank. “Institutional investors have a separate account and as a custodian or clearing member, all margins are in place before I confirm a trade. Besides, the institutional investors have their own risk management and governance framework in place which can prevent misuse of funds.”
Sebi’s proposal seeks to mandate daily upstreaming of all investor funds directly from stock brokers & CMs to CCs. Investor funds in surplus of exchange margin requirements may, in turn, be placed by CCs in very low-risk and liquid overnight money market instruments. The proposal also envisages independent daily confirmation to investors on the position of their daily funds.
The move is likely to impact foreign institutions such as JP Morgan, Citi, HSBC, BNP Paribas, and others that act as CMs and serve foreign clients, including foreign portfolio investors. These may lose a sizeable float income running into thousands of crores.
Even clearing members of domestic banks such as HDFC Bank, Axis Bank, Kotak Mahindra Bank and ICICI Bank, who are custodians and offer clearing services to foreign or domestic institutional clients, including alternative investment funds, will get impacted.
“Currently, the clearing members earn substantial net interest income on the institutional funds lying with them as collateral. Sebi’s move will impact the revenue model of such members, making it unviable to service clients,” said the senior official of a foreign bank, which serves as a clearing member and custodian.
The move will also impact the trading businesses run by foreign brokerages. “The trading cost for clients is subsidised by the interest income on the float money. If this income takes a hit, brokers will have to increase the trading cost to sustain revenues. So, if I was recovering one-third of my expense from trading and two-thirds from interest income, I may have to raise brokerage rates by at least two times to make up for the revenue I was making earlier,” said the official.
Under the current framework, investors post collateral with their stockbroker before executing trades and carry out the settlement of funds or securities through the latter after settlement obligations become clear. For proprietary trades as well as trades of their clients, stock brokers post collateral with their CMs and carry out the settlement of funds or securities through their CMs.
CMs, in turn, post collateral with the CCs for their own proprietary trades and trades of their clients.
The existing framework allows for retention of a certain portion of collateral at every level. So, when a client or investor posts funds with a broker, a part of such funds can be retained by the broker, and a part by the CM, before passing on the balance to the CC.
In the proposed framework, stock brokers shall place the entire clients’ funds with the CMs with segment and unique client code wise allocation of collateral. The CMs would, in turn, place these funds with the CC, allocated against the concerned client. The client funds placed with the CC shall be marked as cash collateral against the respective clients.
